Why you should care

The new hub could be to India what Hong Kong has been to China.

By Simon Mundy

The Daily DoseMAR 15 2018

On a quiet expanse of scrubland in India’s western state of Gujarat, dotted with a few glass-fronted office towers and others under construction, GIFT City does not look like a buzzing hub of international finance.

But the architects of this special economic zone, a pet project of Prime Minister Narendra Modi, insist that it can be India’s answer to Hong Kong: a haven for foreign investors to transact Indian securities with minimal tax and bureaucracy, and for domestic companies to raise funding in foreign currencies.

While growth in activity has been slow, GIFT City’s creators believe it is now poised for takeoff after two major developments in February: new tax breaks announced by the government and a crackdown on offshore trading in Indian equity derivatives that could push investors toward the new zone that lies 450 kilometers north of Mumbai.

Now we’re at the takeoff stage.

V. Balasubramanian, head of BSE’s INX India exchange in GIFT City

“When you’re running this kind of growing economy, one of the fastest-growing in the world, you need a center like this,” says Ajay Pandey, GIFT City’s chief executive. “What Hong Kong was to China, both for inbound and outbound investment, we hope GIFT can be to India.”

Despite recent shocks, such as the controversial banknote demonetization of 2016, foreign investors have shown a strong appetite for Indian assets, with net inflows reaching Rs2 trillion ($31 billion) last year as the Mumbai stock market hit new highs. Yet many investors chose to bet on the Indian market through offshore derivatives trading — mostly in Singapore — to avoid the tax and bureaucratic burdens of onshore trading.

GIFT City has been promoted as a way of bringing this trading volume to India while still offering foreign investors the perks that had led them to trade offshore rather than in Mumbai: low taxes, minimal paperwork and dollar-based transactions.

The project finally came to life in January 2017 when BSE — formerly known as the Bombay Stock Exchange — launched GIFT City’s first exchange, allowing foreign investors to trade using dollars in Indian equity and commodity derivatives. The National Stock Exchange — a younger rival that is now the country’s clear leader in terms of trading volumes — launched its own operation five months later.

While trading slowly picked up, reaching an average daily volume of $270 million in December, foreign investors in Indian equity derivatives still overwhelmingly favored the SGX, which had long been the main offshore hub for such trading.

A sudden boost to GIFT City’s prospects arrived on February 9, when India’s leading exchanges jointly announced that they would no longer provide stock price data to enable derivative trading on foreign exchanges, sending shares in the SGX down more than 7 percent. The move followed consultations with regulators and was triggered by SGX’s attempt to launch trading in Indian single-stock futures, which added to “concern about liquidity growing offshore which is not in the long-term interest of Indian markets,” according to Vikram Limaye, NSE’s chief executive.

The move was attacked by index provider MSCI, which urged the exchanges and their regulator to reconsider the “unprecedented and anticompetitive action,” warning that it could lead to a reclassification of the Indian market in MSCI indices. But Limaye argues that the new financial center provided a readily accessible alternative for investors who had been trading derivatives based on the NSE’s benchmark Nifty index of Indian stocks in Singapore. “You can go to GIFT City and get a dollar Nifty,” he says.

His argument carries more weight thanks to policy moves made just a week earlier in the annual budget, when the government gave a major new tax incentive aimed at luring offshore investors to GIFT City. Even as the government reintroduced long-term capital gains tax on equity investments made in the rest of India, it announced the abolition of a 30 percent short-term capital gains tax on foreigners’ derivative trades at GIFT City — eliminating the tax differential with Singapore and other offshore centers.

“This tax change is the key thing that will break the ice,” says V. Balasubramanian, head of the BSE’s INX India exchange in GIFT City. “Now we’re at the takeoff stage.”

Another key announcement concerned the imminent creation of a unified regulator to handle all rules concerning GIFT City, a major development that could dramatically speed up the zone’s development. “When you have five regulators, you have to go with the lowest common denominator,” Balasubramanian says. “And today all the regulators are focused on the domestic market — for them, this is an outpost.”

BSE is viewing INX India — which it claims is the world’s fastest exchange, with a response time of just 4 microseconds — as an opportunity to gain back lost shares in derivatives trading, having fallen far behind the NSE in trading volumes since the 1990s.

In February it kick-started the new zone’s debt market by listing $600 million of dollar bonds issued by Yes Bank, one of the country’s largest private sector lenders. The issuance involved lower costs than listing debt “in an expensive place like Dubai, Singapore or London,” says Rana Kapoor, Yes Bank’s chief executive.

Pandey argues that the lower costs at GIFT City — notably in terms of real estate and staffing — will be one of the key factors driving financial institutions to steadily expand their presence there, as liquidity picks up. He predicts that trading volumes are likely to increase from April, when the new tax rules come into effect.

But many foreign investors will be cautious, given India’s record of inconsistent tax policy, says Saurabh Mukherjea, chief executive of brokerage Ambit Capital, pointing to high-profile tax disputes with companies such as the UK’s Vodafone. There is still a long-term danger that trading in some securities could drift to offshore “dark pools” run by international brokerages, he warns.

“Trying to set up a mini-Singapore in Gujarat — in theory, there’s a great deal of sense in the idea,” Mukherjea says. “Foreign investors are coming in through offshore centers, and that activity could contribute to India’s [gross domestic product] instead. But foreign fund managers are saying, ‘What assurances do we have that if we set up an operation in GIFT City, the tax laws won’t be changed two years down the road?’ ”